The Hindu Business Line : Fragmented thinking

QUARTERLY reporting for bean counters in companies is becoming as grinding as year-end reporting. Thanks to such pieces of legislation as the Sarbanes-Oxley Act, it is becoming even more rigorous. Apart from facing the stakeholders, companies in the US probably prepare even more to face the analysts. This is not surprising in a country where the analysts owe a certain responsibility for the calls they take on companies and suing them is commonplace. Research appears to prove that even the standard-setting body changes its stance on a few occasions to accommodate the analysts, as a recent research by Christine A. Botosan of the University of Utah and Mary Stanford of the Texas Christian University has shown.

The Financial Accounting Standards Board (FASB) had issued SFAS 14, titling it Financial Reporting for Segments of a Business Enterprise. The crux of the Standard was that it required disclosure of disaggregated information by business and geographic segments but allowed managers flexibility in identifying their reportable segments. Analysts complained that SFAS 14 allowed too much flexibility in defining reportable operating segments and this flexibility was exploited by some firms to avoid providing segment disclosures.

One of the principal objections was that SFAS 14 did not mandate quarterly reporting of segment information. Other objections were quick to follow — limited number of segments for some enterprises, inadequate information about segments, no segmental breakdown and inconsistency of segment information.

The string of objections resulted in SFAS 131 in 1997 — Disclosures about segments of an enterprise and related information. SFAS 131 mandated interim reporting of segment information and asked firms to identify industry segments for external reporting purposes in the same manner that management views operating segments for internal decision making purposes.

Firms were instructed to disclose information about each reportable segment that is similar to the information available to internal decision makers. This flexibility permitted firms to choose their own definition of segment profit regardless of whether it is consistent with generally accepted accounting principles.

The research conducted was with an intent to deciphering managers' motives to withhold segment disclosures. Results indicated that managers of firms that were forced to shift to SFAS 131 withheld segment information under the erstwhile SFAS 14 to protect profits in less competitive industries. SFAS 14 required disclosure in case the segmental sales, assets or profits exceeded 10 per cent of their respective totals.

Adoption of SFAS 131 brought the mean per cent of firm sales to 31.2 per cent which proved analysts fears that multi-segment firms masqueraded as single-segment firms under SFAS14. An additional finding of the research was that SFAS 131 encouraged greater reliance on public information for analysts to prepare their forecasts which affected forecast accuracy a bit.

Of course it must be mentioned that the research was principally focused on "change firms" — firms that stayed indoors during the SFAS 14 era but were forced to disclose some segment as per SFAS 131.

However, the research was quick to point out that firms did not use the latitude in SFAS 14 to mask poor performance.

In India, the Institute of Chartered Accountants of India (ICAI) has issued Accounting Standard 17 on segment reporting. This is mainly applicable to listed companies and certain other companies. The Reserve Bank of India has issued a separate notification for segment reporting for banks to build in the special requirements of banks that were not in the Standard issued by the ICAI.

This Standard draws heavily from SFAS 14 by identifying segments on the basis of business or geography and using the 10 per cent formula. Although we are unaccustomed to the practice of answering analysts' calls, disclosure of segment information is dissected by the analysts when issued.

As the study has confirmed, the "10 per cent formula" gives a window to companies to suppress some segment information. While the quarterly reports do provide segment information, it becomes a statistical exercise after some time.

The ICAI would do well to examine the utility of the segment information being provided now, consult analysts and SEBI and issue a Standard that meets the requirements and suffers from no ambiguity.

(The author is a Hyderabad-based chartered accountant.)

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